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Summary 4 key fundamental factors are reported across industries in Energy and Basic Materials. They give valuation status of an industry relative to its historical average. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Energy and Basic Materials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name. For example, D-P/E = (AvgP/E – P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. A relative variation makes little sense. That’s why we take the simple difference: D-ROE = ROE – AvgROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 12/21/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Energy Equipment&Services 20 24.2 17.36% 0.72 1.73 58.38% 8.65 35.34 75.52% -10.91 7.34 -18.25 Oil/Gas/Fuel 14.93 18.53 19.43% 1.65 3.35 50.75% 15.48 29.03 46.68% -15.55 4.47 -20.02 Chemicals 18.3 18.48 0.97% 1.31 1.21 -8.26% 35.82 25.37 -41.19% 8.71 6.74 1.97 Construction Materials 51.27 21.44 -139.13% 1.36 1.16 -17.24% 58.56 40.5 -44.59% 9.34 5.77 3.57 Packaging 21.58 17.96 -20.16% 0.91 0.61 -49.18% 23.15 20.09 -15.23% 18.23 8.34 9.89 Metals&Mining 19 19.83 4.19% 1.2 2.65 54.72% 13.94 25.53 45.40% -19.39 -8.6 -10.79 Paper&Wood 30.98 21.27 -45.65% 0.92 0.72 -27.78% 21.8 22.81 4.43% 8.35 4.99 3.36 The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. In all cases, the higher the better. Price/Earnings : Price/Sales : Price/Free Cash Flow : Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF in Materials (NYSEARCA: XLB ) and energy (NYSEARCA: XLE ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion In one month, XLE has fallen by 11.3% and XLB by 6.3%, both underperforming SPY by a wide margin. The reason is obvious looking at WTI oil price: it hit last week a level not seen since the second half of 2003. In this meltdown, the five more resilient S&P 500 stocks in Energy and Materials on a 3-month period are Airgas Inc (NYSE: ARG ), Chevron Corp (NYSE: CVX ), E. I. du Pont de Nemours (NYSE: DD ), Tesoro Corp (NYSE: TSO ), Valero Energy Corp (NYSE: VLO ). The two latter are refiners. Oil price is not a major driver of their profitability, and concerns about a possible end of the crude oil export ban seem to disappear. The improvement in valuation ratios for all industries of these sectors since my last update is just a consequence of lower stock prices. The harder the fall, the better the “improvement”. It is not a signal that things are really improving for oil and gas companies. It is even the opposite: the quality measured by the ROE industry factor went down. As a group, energy and metal/mining are looking like a nest of value traps: the 3 valuation ratios point to underpricing, whereas the quality factor (D-ROE) is deep in the red and worsening. This is not true for all the oil industry: we have seen that refiners are doing quite well and several of them have hit an all-time high in November. Some of them are also in the very best of the S&P 500 in my value and quality-based screens. No industry in these two sectors looks globally very attractive. However, comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price. The next table shows a list of stocks in the Energy and Basics Materials sectors. They are all cheaper than their respective industry for 3 valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity. This screen updated and rebalanced monthly has an annualized return about 17% and a drawdown about -65% for a 17-year backtest. The corresponding sector ETFs XLE and XLB have an annualized return of respectively 8.32% and 6.79% on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding a few trading rules and market timing. This is not investment advice. Do your own research before buying. ATW Atwood Oceanics Inc. ENERGYEQUIP DOW Dow Chemical Co (The) CHEM EMN Eastman Chemical Co CHEM IOSP Innospec Inc CHEM KS KapStone Paper & Packaging Corp FORESTRY LYB LyondellBasell Industries NV CHEM REX Rex American Resources Corp OILGASFUEL TSO Tesoro Corp OILGASFUEL VLO Valero Energy Corp OILGASFUEL WNR Western Refining Inc OILGASFUEL If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article. Scalper1 News
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